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Comic Books Make Sense at GameStop

The small experiment shows the company is working to turn things around.

GameStop(NYSE:GME) shareholders: Do you feel lucky? The brick-and-mortar video game retailer currently trades at a ridiculously low price-to-earnings ratio of 4.5 times next year's estimated earnings, with a dividend yield over 10%. A valuation that low is usually ominous, suggesting investors believe GameStop's earnings will rapidly decline in the coming years.

There's reason to be nervous. GameStop is facing the daunting prospect of remaining a brick-and-mortar retailer of physical video games, in an age in which traffic is migrating online and more games are being released in downloadable formats. There isn't really a great solution to the problem and the company announced in mid-June that it is "in exploratory discussions with third parties regarding a potential transaction." Leading up to that announcement, But GameStop's strategy seems to have been to prudently decrease its store footprint, while also diversifying into non-video game products.

In early June, GameStop unveiled its newest attempt at diversification, announcing it would begin selling comic books in a 40-store trial.

Image source: Getty Images.

Dipping a toe in the ink

The new trial will include 20 GameStop-brand stores and 20 ThinkGeek stores. ThinkGeek is a pop-culture toy company GameStop purchased in 2015. The company will partner with Diamond Comic Distributors to install comic racks in these test stores, and will sell mostly Marvel and DC Comics, with a few titles from Image and Oni Press. For perspective, GameStop operates some 7,200 stores in 14 different countries, so this is only a drop in the bucket.

Can GameStop avoid Hastings' fate?

GameStop is likely pursuing comic books due to the success of its burgeoning collectibles business, which it entered via the ThinkGeek purchase in 2015.

The company said in a statement that comics "are often a part of our promotional entertainment industry environment, including video games ... This is just a small launch to bring comics to some of our collectibles stores as they fit with the current trend of collectibles that are performing in the market. ... Should this prove successful, we may consider rolling out to additional stores in the future."

While GameStop expects its overall revenue and earnings to decline in 2018, the collectibles segment grew an impressive 29% last year. The problem? Collectibles only made up 6.9% of overall sales.

Clearly, the company is making a push to become more of a "game culture" store, with toys and now comic books playing into the theme. According to management, the collectibles market will reach $16 billion by 2019, leaving the company with an opportunity to expand on its $640 million in 2017 collectibles revenue. Last year, the company created a new position, senior vice president of collectibles, and hired Janet Bareis from Walmart to lead the effort. GameStop is also giving hundreds of stores a makeover this year. The new format is split 50-50 between video games and collectibles; it's aimed at expanding GameStop's customer base to non-hardcore gamers.

Will it be enough?

GameStop's efforts to find ancillary revenue in its stores are to be applauded, but investors should know significant challenges remain. Even though the collectibles business is growing nicely, 2017 collectibles revenue actually fell short of management's initial target of $650 million to $700 million.

In addition, the core gaming business -- encompassing consoles, new games, used games, and accessories -- still accounts for almost 80% of GameStop's sales. These segments are all projected to decline coming off the release of the Nintendo Switch last year, with management projecting revenue declines of 2% to 6% in 2018.

Meanwhile, more game publishers are unveiling subscription plans. These could potentially peel off some of the used-game customers who accounted for over 23% of GameStop's business last year.

In addition, Netflix's upcoming Minecraft: Story Mode allows viewers to make choices for on-screen characters in an interactive fashion. While not exactly a game, the announcement made some worry that the streaming giant could eventually get into video games. Netflix, for its part, denied it was getting into gaming, and I believe it (there are bandwidth obstacles to streaming games). Still, the announcement gave GameStop investors yet another thing to worry about.

So, selling comic books may help add a few dollars and is certainly synergistic with gaming and geek culture (I actually don't know why GameStop hadn't thought of this before). But it probably won't make a huge difference in the context of these larger trends.

Tempting, but...

GameStop's minuscule P/E ratio and 10% dividend yield are awfully tempting, and though I own some shares, it's one of my lower-conviction picks and a very small allocation. Still, if the company can figure out how to make its stores "experiential" enough to keep traffic coming, and if physical games don't decline as fast as feared, the stock could be a good buy. But make no mistake: Despite collectibles growth and the new comic-book venture, this is a very high-risk investment.